When employers allow participant loans in their pension plan, it provides great incentive for employees to defer more money into the plan.  This is because it saves participants from having to take a loan out from a bank and from having to remove money from their retirement fund and suffering the inherent tax consequences.

Why can taking a loan from a qualified plan be better than taking a loan from a bank?  It’s because the participant is really borrowing the money from his/herself;  when they are required to make payments on the loan,  all of the money goes back into their own account- including the interest.

Interest must be calculated by using an approximate rate based on rates charged by businesses in the lending industry. For loans extended to participants on military leave,  the interest rate cannot be higher than 6%.

When a loan is taken,  it must be secured by 50% of the participant’s vested account balance.  In other words,  if a participant has a vested account balance of $40,000 the maximum loan they can take is $20,000.  The maximum loan allowed for any participant with a vested account balance equal to or greater than $100,000 is $50,000.  Once the loan is secured at 50% it is always considered adequately secured,  even if the account balance falls under the secured amount.

The repayment period of the loan may not exceed five years.  The only exception to this rule is if the loan is used to purchase the participant’s principal residence.  Extensions of loans are only acceptable during: unpaid leaves of absence,  loan refinancing and military service.

When requesting a loan,  make sure it meets the applicable tax provisions under the IRS,  otherwise the loan could be considered a taxable distribution.